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What is a Blockchain, and why is it growing in popularity?

Last year, Ripple Labs, creator of the virtual currency XRP, was fined $0.7 million (~£540,000) by the US Financial Crimes Enforcement Network for violating regulations concerning money laundering.

Some observers cite this as the moment cryptocurrencies shaved off their startup hipster beards, put on a tie, and went mainstream. Being fined by a regulator means that you’re part of the financial services industry at last.

Given that the first and most famous cryptocurrency, Bitcoin, was launched back in 2009, it has taken the wider industry a relatively long time to warm to it. But now suddenly everyone is talking about Bitcoin’s underlying blockchain technology as a disruptor of potentially massive proportions: Sweden is trialling a new land registry that uses a blockchain, dozens of startups spanning numerous sectors are poking around at possible uses, and importantly policy makers such as the European Parliament have voted in favour of a more hands-off approach towards blockchain tech regulation.

So, what’s the connection between Bitcoins and blockchains? And why the renewed interest in the latter?

It's kinda like a database

A blockchain is a ledger of records arranged in data batches called blocks that use cryptographic validation to link themselves together. Put simply, each block references and identifies the previous block by a hashing function, forming an unbroken chain, hence the name.

Put like this, a blockchain just sounds like a kind of database with built-in validation—which it is. However, the clever bit is that the ledger is not stored in a master location or managed by any particular body. Instead, it is said to be distributed, existing on multiple computers at the same time in such a way that anybody with an interest can maintain a copy of it.

Better still, the block validation system ensures that nobody can tamper with the records. Rather, old transactions are preserved forever and new transactions are added to the ledger irreversibly. Anyone on the network can check the ledger and see the same transaction history as everyone else.

Effectively a blockchain is a kind of independent, transparent, and permanent database coexisting in multiple locations and shared by a community. This is why it’s sometimes referred to as a mutual distributed ledger (MDL).

There’s nothing new about MDLs, their origins traceable to the seminal 1976 Diffie–Hellman research paper New Directions In Cryptography. But for a long time they were regarded as complicated and not altogether safe.

It took the simpler blockchain implementation within Bitcoin to turn things around. The permanence, security, and distributed nature of Bitcoin ensured it was a currency maintained by a growing community but controlled by absolutely nobody and unable to be manipulated.

Following the launch of Bitcoin, dozens of vigorous tech startups have vied with each other to produce the Next Big Thing in blockchain-based cryptocurrency, from the relatively-well-regarded Ethereum to the frankly ludicrous Coinye West.

A notable drawback of blockchains is that their distributed nature demands constant computational power in many multiple locations, and all the on-going accumulated (electrical) power that entails. “You may have heard a myth that Bitcoin consumes the energy consumption of Ireland,” says Michael Mainelli, executive chairman of financial tech think tank Z/Yen. “That’s absolutely wrong. It’s only half the energy consumption of Ireland.”

So when one large bank recently announced that it planned to bring out 400 different kinds of virtual currency, they risk consuming 200 Irelands’ worth of power just to keep them running.

In fact, the renewed interest in blockchains has less to do with inventing yet more currencies to spend at hipster cafes than with realising the benefits of an MDL in cutting costs and reducing the power of monopolies elsewhere in the financial services industry.

“Financial services are based on mistrust,” explains Mainelli. “So what do we do? We set up a registry and get someone to handle the transactions. If I register my sailing boat and then sell it, the transaction is safeguarded. If something then goes wrong with the boat, we can go back to the registry and look at the records.”

This in turn produces a monopoly of third-party services to manage exchange and settlement in the financial industry, which can be expensive and is not without risk of manipulation—the Libor scandalbeing just one recent example.

Blockchains: For when everyone distrusts each other

But if the registry was not owned by a central third party but sitting on multiple machines and everybody had copies, it would have resilience and looking up transactions would be quick. And with the data being immutable once entered in the ledger, it would provide a permanent record that financial regulators and auditors could quickly fall in love with.

In principle, MDLs have a much wider potential beyond financial services. Solving the issue of trust and ensuring non-malleable permanence of the data could make it invaluable for managing the provenance of assets, date-stamping events, geo-stamping those events in a specific location, establishing identity, and so on.

In other words, it’s a souped-up audit trail for anything you like, not just a cryptocurrency. It’s not just one system. Indeed, the situation can be compared of the database revolution of the 1970s: there wasn’t just one type or structure for a database, you created the specific database you wanted for your own purposes.

The current resurgence in interest in blockchains, therefore, could be a welcome sign that sanity is breaking out in the financial technology (fintech) investment arena, as those working in financial services and other sectors begin to recognise the practical benefits beyond the Bitcoin hype.

Indeed, one day we may look back on this time as a transitional period when everything changed. Blockchains could become the norm for data records sooner than we think. Mainelli offers an example: “Imagine I showed you an app on my phone that showed all the ski resorts around the world. You wouldn’t say ‘Wow, does that use a database?’ Well, duh, what else?

“In about three or four years, you’re going to be looking at an identity app and perhaps you’ll be saying ‘Wow, does that use a distributed ledger?’"

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